Sodexo (EPA:SW) May Have Issues Allocating Its Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Sodexo (EPA:SW), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Sodexo:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.081 = €892m ÷ (€21b - €9.8b) (Based on the trailing twelve months to August 2023).

Thus, Sodexo has an ROCE of 8.1%. Even though it's in line with the industry average of 8.0%, it's still a low return by itself.

View our latest analysis for Sodexo

In the above chart we have measured Sodexo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Sodexo.

How Are Returns Trending?

When we looked at the ROCE trend at Sodexo, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.1% from 14% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that Sodexo has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Sodexo is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 24% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you'd like to know about the risks facing Sodexo, we've discovered 2 warning signs that you should be aware of.

While Sodexo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.